Inventory conversion is the act of turning a company's product, or inventory, into sold merchandise, and the inventory conversion rate is the rate at which the inventory is sold. This is a significant value, particularly for retail businesses, which often need to quickly turn over their inventory. The inventory conversion period represents the number of days inventory is held before being sold and replaced. This is important for retailers who aim to quickly turn over their stock or need to plan purchases and inventories. The inventory conversion period may be found by calculating the inventory turnover ratio, which indicates how many times stock is turned over during a year.
Knowing how much goods that have been sold cost, one can take that figure and divide it by the year's average inventory. The resulting figure will be the inventory turnover ratio. The use of an average turnover figure ensures that the resulting figure allows for any seasonal variations in the level of inventory. The result of this calculation indicates how many times, on average, an inventory has turned over during an accounting period. A retailer may find this useful, especially if applied to individual product lines or categories, because it may indicate the possibility of inventory loss through obsolescence or deterioration in a product over time.
Once a retailer knows the inventory turnover ratio, the average number of days for which inventory is held can be computed. Total number of days in the overall period, such as a year, is divided by the newly determined ratio. If inventory is turned over 10 times during a year, for example, then each item of stock is held for an average of 36.5 days on the basis that there are 365 days in a year.
Depending on the type of goods in which the enterprise deals, a slow inventory conversion rate may be a sign of potential liquidity problems. The required rate of inventory conversion would likely be very different for a luxury furniture shop compared to a supermarket or similar fast-moving consumer goods outlet. Retail outlets always must consider the need to keep inventories as low as possible and balance this with the need to supply goods to customers on demand and avoid waiting times.
The rate of inventory conversion in regard to each product or category is a guide to the future purchasing policy for those products. The average inventory turnover rate alone would not be a sufficient guide, because the enterprise must plan ahead for spikes in demand that result from holidays and festivals. A comparison of inventory turnover of goods over time may give an indication of changing consumer tastes. Modern technology such as radio frequency ID enables wholesalers and retailers to check with great accuracy the stock levels in warehouses and in the shops and enables these businesses to fine-tune their purchasing policy.